Educational Articles

This Unfolding LNG Story Could Have a Very Happy Ending

Dominic B. Silva
| May 08, 2012

Natural gas was thought to be in short supply fairly recently, driving prices to a record high of approximately $13 per million British thermal units (mmbtu) in 2005. However, new drilling techniques have enabled energy companies to extract reserves that were previously inaccessible. One such method is fracking, (also known as horizontal hydraulic fracturing) in which water, sand, and various additives are pumped underground at high pressure causing shale rock to fracture and create space for gas to be extracted. With the new technique, total natural gas production averaged nearly 65 billion cubic feet per day (bcfe) in 2011, a figure that was roughly 25% higher than in 2006.

Advances in drilling technology, together with mild 2011 winter-weather conditions, which cut heating demand, have resulted in flush inventories, (2.5 trillion cubic feet). According to the United States Energy Information Administration (EIA), the country’s storage facilities are holding 60% more gas than normal. What’s more, estimated underground reserves have surged in recent years with the development of various shales. This abundance has pushed gas prices to a 10-year low of roughly $2 per mmBtu, forcing many companies in the upstream category, including EnCana Corporation (ECA) and Chesapeake Energy Corporation (CHK), to curtail production.

With decades of supplies in hand, a number of domestic producers are seeking permission to sell natural gas overseas, in many cases in the form of liquid natural gas (LNG). The liquefaction of natural gas (which involves that removal of dust, acid gases, helium, water, and heavy hydrocarbons) enables the transportation of massive amounts of fuel from areas where natural gas is abundant and relatively inexpensive to areas where production is insufficient or infrastructure (pipelines) is unable to meet demand.

While this key source of energy sells for approximately $2 per mmbtu in North America, its price tag is four to five times that in certain overseas markets. In particular, it fetches as much as $12 per mmbtu in Europe and $16 per mmbtu in Asia. Consumption of LNG is on pace to grow sharply in the years ahead in these markets, driven by a build-out of natural gas fired electric power generation capability in Asia; reduction in nuclear power generation in LNG importing regions, such as Japan and Europe; and conversion of coal- and oil-fired power generation to natural gas.

One company eager to take advantage of more lucrative overseas markets is Cheniere Energy (LNG), which recently secured approval to export LNG from the yet-to-be-built Sabine Pass in Louisiana. LNG’s essential position in satisfying energy demand has attracted global energy producers to the project, with BG Group (England), Gas Natural Fenosa (Spain), Gail Limited (India), and KOGAS (Korea) agreeing to purchase a total of 10 million tons annually. Once complete in 2015, Sabine will have an annual capacity of 18 million tons.

Although the company is currently losing money, Sabine should enable Cheniere to generate substantial profits. That’s because Sabine would be just the fourth LNG export terminal in the Western Hemisphere. Unlike the three competing sites, though, Sabine will be the only facility located in close proximity to cheap shale gas. This project’s tantalizing prospects has enticed private equity behemoth The Blackstone Group (BX) to contribute at least $2 billion in financing through subsidiaries.

A number of other energy producers plan to build similar exporting facilities, which may eventually boost North American gas prices higher. Even if natural gas were to approach $5 per mmbtu in North America, LNG shipments abroad would be immensely lucrative.

The surge in natural gas production in the United States is resulting in new profit opportunities. One that offers massive potential returns for investors is Cheniere Energy, which is scheduled to start exporting LNG in 2015.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.